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The U.S. Supreme Court ruled that investors can not sue companies that directly participated in or directed the making of fraudulent statements in mutual fund prospectus statements that harmed investors.

Background

Janus Capital Group provided the initial seed capital of $100,000 required by federal law to start up a mutual fund known as the Janus Investment Fund; helped register the Janus Investment Fund with the federal Securities and Exchange Commission (SEC); selected the third parties needed to launch and operate the fund; and the fund's investment adviser (a wholly owned subsidiary of the holding company that sponsored the fund startup) produced a prospectus for the fund that contained significant misrepresentations, statements that investors alleged amounted to fraud.

Investors sued the fund investment advisers and Janus Capital Group, arguing that both entities were so closely linked to the fund and the fraudulent conduct as to be liable for the fraud that was carried out through publication of the prospectus. Defendants responded that they should not be liable to individual investors because U.S. Supreme Court precedent insulates aiders and abettors in securities fraud cases.

Attorneys with AARP Foundation Litigation filed a "friend of the court" brief pointing out that private enforcement action (the ability of investors to sue directly) is a critically important tool. Federal and state governments are too overwhelmed and cash-strapped to effectively enforce laws; governments are generally strangers to the transactions that give rise to allegations of fraud; private actions have a broader reach, as the government is limited in its oversight — particularly so in the case of mutual funds; and, private enforcement actions are the only way to adequately compensate victims since governmental agencies can impose only limited fines. Finally, the brief argued, private actions send a strong message to financial industry professionals as to their duties of transparency and responsibility, a message that is also important for investors to hear in order to have confidence in the markets. As evidence of this, the brief pointed out, once the flaws in the prospectus materials were revealed, investors departed from the fund in droves.

The Court disagreed. "The maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it … One who prepares or publishes a statement on behalf of another is not its maker," ruled the Court's 5-4 majority, which declined to hold Janus Capital Group liable for misstatements in Janus Investment Fund prospectuses.

What's at Stake

More people than ever are investing in financial products and securities on their own and through Individual Retirement Accounts, employer-sponsored 401(k) and similar plans. Misconduct by industry professionals can harm all market participants. The stakes for investors inside and outside of retirement plans are substantial. Investors must have not only accurate and complete information about their investment vehicles, but they must also be armed with the legal tools necessary for enforcement of their rights.

Case Status

The U.S. Supreme Court's decision in Janus Capital Group v. First Derivative Traders dismisses the case.